The Dark Side of Our Deficit

President Ronald Reagan once said: “We don't have a trillion-dollar debt because we haven't taxed enough; we have a trillion-dollar debt because we spend too much.” While true in 1982, it is more true now. And for reasons that I shall discuss, the implications of our deficit will be very far reaching—affecting our foreign policy, standard of living and even our fundamental way of life.

Federal spending, and subsequently our deficit, are surging at a pace not seen since World War II. However, because of accumulated surpluses, we didn’t truly become a debtor nation until 1985. We are now a debtor nation of over $11 trillion dollars, much of it held by foreign nations.

I agree wholeheartedly with Budget Committee Ranking Member Ryan when he says that these deficits, if left unaddressed, will continue to weigh on our budget each year and will threaten our ability to make sound decisions for future government spending. But there is an even darker side to our growing deficit that has not yet received much attention - the geopolitical significance of our growing national debt.

In the emerging world order, global dominance is no longer decided by armies and aircraft, but by greenbacks and Euros, Rubles and Renminbi. Countries are now projecting power with their economic might—and in new and innovative ways.

While the global stage may appear complex there are really just two basic types of players on it: creditor nations and debtor nations. Who are they? Creditor nations are oil-rich Islamic states such as Saudi Arabia and Kuwait and resource-rich states such as China and Russia who have developed huge holdings in Western currency, debt, and industries. And the Debtor nations are us -- Western governments -- who have slipped deeper and deeper into debt.

Saudi Arabia, Kuwait, China, and Russia are not richer than the United States or other Western nations, but they are now the creditors of these Western nations. They are becoming our lenders because they are channeling their capital into holding our currency, debt and more recently, owning our corporations through sovereign wealth funds. A new relationship is emerging -- one that undermines the West.

There is something else striking to pay attention to: The debtor nations are Western democracies and the creditor nations are autocracies. Because our creditors are autocracies, they continue to amass excess international reserves instead of spending capital to improve the lives of their people.

Nations need some foreign currency reserves. But several non-Western nations are holding dollars and U.S. Treasuries in amounts that are far in excess of those needed to support their own currency or provide stability. And recently, creditor nations are no longer satisfied with Treasury bill returns. These nations are now also channeling excess foreign reserves into sovereign wealth funds and other financial vehicles which make direct investments in our companies, assets and infrastructure.

Whether these nations invest in T-Bills or our companies, the truth remains that becoming another nation’s major investor and creditor is a very effective way of achieving influence over it.

Given their growing economic might, the new "creditor nations" will have the power to further their geopolitical ambitions by using a powerful weapon of international diplomacy and warfare: economic statecraft. When a country uses the strength of its economic relationship to influence a weaker country's foreign and domestic policies, alliances and actions, economic statecraft is at work.

Traditional wars will not go away, but their beginnings and outcomes will be determined by economic rather than military might.

The fact is that by borrowing so extensively from other nations, we have already significantly compromised our ability to promote democracy, the rule of law, human and civil rights reforms, and environmental policy.

Please allow me to discuss one creditor nation in particular to underscore the statements I just made. And this nation is China .

At the opening ceremony of the historic Olympic Games in Beijing last summer, one billion people around the world viewed the glory and pageantry of China’s carefully designed and choreographed spectacle. China’s 5000 year history was presented in an astounding display of technology and artistry that was seven years in the making. The technical demonstration was unprecedented--an LED screen 147 meters long and 22 meters wide at the center of the display and tiny LED beads adorning the costumes of the performers. The artistic marvels that the performers and technology were able to achieve together thrilled us all.

As I watched, however, I began to feel a growing unease. The beauty of the display could not chase away the sense that I was seeing the future. It was shocking and new. While I appreciated the beautiful images on the huge LED screen, I realized: America does not possess the technology to produce LED screens as large as the one I watched. Nor have we been able to put on a performance that technologically spectacular. The incredible precision of the drummers and martial artists, moving as an army of one, showed us the Chinese people’s ability to channel their individualism into the triumph of the whole.

Something had been happening in China—something of which the United States had not been fully aware. Until that moment, I had not grasped this startling fact: China has been slowly and quietly supplanting the United States as the most important nation on earth. With the flash of light and color and the power of its mass pageantry, China was showing us a future in which non-Western nations would awe us with their technological and economic might. And they were showing us all of this without one hint of traditional military muscle.

Anyone who does not believe that China has a far reaching geopolitical agenda should look at their former leader Deng Xiaoping’s “24 character” strategy. Deng developed this policy in the 1990s to bring China back to the prominence and power on the global stage which it had enjoyed for centuries. His policy consists only of 24 Chinese characters, and continues to be quoted—and followed--by the current Chinese leadership. It is as follows: “observe calmly; secure our position; cope with affairs calmly; hide our capacities and bide our time; be good at maintaining a low profile; and never claim leadership.” Take note: people have become Speaker of this body by following a similar strategy. And it is a policy that the United States could learn from, too. China has been “biding its time,” and is now successfully regaining its stature and global position.

The Economist reported recently that “roughly 300 million people in China live on less than a dollar a day” and at the same time, China was adding about $1.25 per Chinese citizen per day to its international reserves.[1] China holds well over 1.5 trillion dollars of our currency and debt.

And as our creditor, the Chinese have begun to flex their economic muscle. The head of China’s new $200 billion sovereign wealth fund recently warned us that China’s fund will not invest in countries that in its opinion use “national security” as an excuse for protectionism. His comments are clearly intended as a warning to America not to place limits on foreign investments in its companies. It is the type of directive that we can expect more of from China and our other creditors in the future.

But there are strong signals now from Beijing that China may think investing in the United States and Europe is not sufficiently economically attractive to continue at this pace.

Our major creditors increasingly have the power literally to destroy our economy without destroying their own. They can do this simply by refusing to buy our Treasuries, agencies and currency, or worse, by dumping them on the world market. Although the dollar has been the world’s reserve currency since World War II, it may not continue to be so forever. And if this changes, the demand for our dollars and T-bills will crash.

Without enough demand for our debt, the United States would either have to offer huge interest rates to entice the remaining market into purchasing our debt, or print more money leading to a crashing dollar and massive inflation. Although each of our creditors would suffer from the decline in value of our debt and currency, they would suffer less than we would -- which is why I call this strategy the “nuclear option”.

The “nuclear option” allows the creditor nation to present its debtor nations with terms under which lending will continue. For example, China could press the United States to buy Chinese goods over the goods of other nations or could require us to open up our markets on terms unfavorable to the United States. China could use its economic influence over the United States to curb our support for Taiwan or other allies.

Even the United States’ support for Israel will not be off the table as the United States seeks more and more capital from nations which do not share our foreign policy objectives or even our view on fundamental human rights. We are so vulnerable to our creditors, not only because we owe them so much now, but also because we need to continue borrowing from them. At some point, our nation could be forced to set aside our foreign policy goals and even our ideals because the leverage of our creditor nations over us will be too great.

Many of our nation’s financial institutions have significant ownership by sovereign wealth funds. Even if the non-Western creditor nations do not overtly try to impose their agendas on US companies, foreign-owned US firms will naturally start to adapt their own corporate culture to the sensitivities of their owners. These companies may decide to observe certain religious or cultural restrictions on behavior that would offend their owners or refrain from making investments in businesses that would not seem appropriate to their largest shareholders. And these changes will affect our American way of life.

Sovereign wealth funds claim that they will be passive investors and have no role in corporate governance over the companies in which they invest. That is what they say now, but American pension and investment funds have frequently imposed political views on their investment decisions and their decisions as shareholders as well. Examples abound of our funds divesting from South African companies, from tobacco and alcoholic beverage companies, from companies that do business in Iran, and from companies perceived as harming the environment. Similarly, sovereign wealth funds can be expected to impose their own cultural and political agenda on both their investment decisions and their decisions as shareholders of Western companies. We should expect sovereign wealth funds to invest in and extend their influence over not only our financial institutions, but also our core businesses, media and lifestyle companies--such as Google, News Corp., Microsoft and Apple.

In the past, the United States would have worked to bring change to these autocracies that are now our creditors. But now our position as a debtor nation will make it increasingly difficult for the United States to promote democracy abroad, to advocate for the rule of law, to demand human rights reforms, to set global environmental standards, to sanction rogue nations, or even to provide assistance to our traditional allies. Many of our national security objectives will need to be laid aside as we compete to attract and retain foreign capital.

If the United States is still the most powerful military nation on earth, it is not likely to remain so for much longer if we continue to increase our national debt. Only a nation with a strong economy can afford to spend resources on both maintaining a strong military and investing in the research and development of new weapons systems and defense applications.

A state does not need a dominant military in order to influence global politics—just lots of money. But military superiority may soon follow. A nation with excess capital can spend money on the best technology and training, whether developed internally or purchased abroad. For example, China is rapidly developing technologically advanced blue water navy that will be capable of challenging the U.S. fleet. And Russia has developed planes, the Su30 and Su35, each of which can take out five of our F-15s before our aircraft can even spot them.

The perils of being a debtor nation at the mercy of one’s creditors are as evident today as in the 1950’s when the United States employed economic statecraft against its now-stalwart ally, Great Britain. Britain had recently occupied the Suez Canal Zone, together with France and Israel, in response to Egyptian President Nasser’s decision to nationalize the Canal Zone. And they had no intention of returning it to Egypt—until the United States demanded otherwise.

At that time, Britain depended on U.S. support to maintain the pound’s peg to the dollar. Thus, as Britain’s most important creditor, the United States simply demanded that Britain comply with a UN General Assembly resolution that called for Britain, France and Israel to withdraw from the Suez or we would drop support for the Pound. As expected, within weeks, Britain withdrew from the Canal Zone, and put the Canal back into the hands of the Egyptians.

China’s influence over its debtors’ foreign policy is growing. In 2008, the UK government stopped advocating for a free Tibet and formally recognized the legitimacy of Beijing's direct rule over Tibet. And we are responding to their pressure also—on a recent trip to China, Secretary Clinton stated that the U.S. would still press China on human rights issues, but she wouldn’t allow our pressing on these issues to interfere with “the global economic crisis, the global climate change crisis and the security crisis.” The Washington Post noted recently, "Pelosi Mum On Rights Before Trip to China". The political reality is very simple - it is hard to press for human rights in China when we need to be concerned about maintaining Chinese investment in our economy.

The answer is simple, yet extremely difficult to achieve: The United States needs to stop increasing our deficits. We need to bring them down, reduce our foreign borrowing and improve our global economic standing.

If we are not able to change the trajectory we have begun, then what? At some point, America will have a melt-down. The world will lose confidence in our currency, debt and markets. And it will be too late to change course.

At that time, we shall face great uncertainties on the domestic front. Our current reduced level of consumption -- cars, electronics and consumer goods -- will no longer be possible on a national scale or a personal level. We shall face pressures from abroad which will change our own way of life—in small ways at first and then, in big ways. This will lead to many unforeseeable changes in our business practices, our domestic policies and our alliances.

We are already learning that we cannot impose our views on democracy, civil rights, environmental policy, and a fair legal system on other sovereign nations. At best, we may be able to preserve and defend these principles at home. It will not be the US anymore that will be speaking softly and carrying a “big stick”.

We need to start a public debate on the consequences of our national debt and spending--to save our country and our way of life. We need to explain on main street, on Wall Street, at town hall meetings and in our halls of Congress why we have to rein in our spending and decrease our deficits now. Looming debt has made increases in spending simply impossible to consider, yet the Democrat-controlled Congress seems to be throwing America even further into the abyss by its rampant over-spending. If we all voice our concerns and bring this message to the American people, we can still turn this around and preserve the pact that America made with its citizens long ago: life, liberty, and the pursuit of happiness.

Comment on this item

Name:

Email Address:

Comments:

Email me if someone replies to my comment

Note: Gatestone Institute greatly appreciates your comments. The editors reserve the right, however, not to publish comments containing: incitement to violence, profanity, or any broad-brush slurring of any race, ethnic group or religion. Gatestone also reserves the right to edit comments for length, clarity and grammar. All thoughtful suggestions and analyses will be gratefully considered. Commenters' email addresses will not be displayed publicly. Gatestone regrets that, because of the increasingly great volume of traffic, we are not able to publish them all.

The articles printed here do not necessarily reflect the views of the Editors or of Gatestone Institute.
Both reserve the right not to publish replies to articles should they so choose.
Gatestone Institute is a 501(c)3 not-for-profit organization, Federal Tax ID #454724565.